Another showdown looming with creditors

Three things are conspiring to lead Greece towards another conflict with euro zone creditors and another potential debt payments crisis. First, the government is finding it politically almost impossible to push through the reforms required to complete the second review of the bail-out programme. Second, some key euro zone governments facing populist insurgents at the polls are disinclined to make any concessions to Greece. Third, the long-running feud between euro zone institutions and the IMF over how to deal with Greece is coming to a head. In line with our long-standing forecast, we expect the government's political travails to mount in the coming months, and the risk of another early election is rising. We continue to forecast that Greece will leave the euro zone by the end of our medium-term forecast period.

Greece's euro zone creditors are insisting on completion of all reforms under the second programme review and on formal IMF participation in the bail-out programme before they release further funds to Greece. On January 30th Klaus Regling, the head of the European Stability Mechanism (ESM, an inter-governmental assistance fund for countries in the euro zone), the body responsible for loan disbursements to Greece under the third economic adjustment programme, said that Greece must complete the second programme review and the IMF must formally support the programme before the ESM would release further loan tranches. On January 31st the German Ministry of Finance made almost exactly the same points in a public statement.

A euro zone chorus

The euro zone statements came days after the leaking of the IMF's latest report on Greece, which warns that the growth of Greece's public debt will "become explosive" after 2022 and could climb to the equivalent of 275% of GDP by 2060 (from 180% now). Last year the IMF published a report that said that Greece's debt was "highly unsustainable" and presented a rather bleak growth outlook even under a best-case reform scenario. An ESM working paper in May 2016 suggested that Greece's public debt could fall to 105% by 2060, assuming that it implements the bail-out programme in full. However, other projections suggested that the debt would be higher.

The IMF is not officially participating in the current programme, but the ESM and Germany are now effectively insisting that the Fund's financial and technical participation is a sine qua non for the continuation of the programme. The IMF board is meeting on February 6th to discuss the institution's role in the bail-out programme. Given the stark conclusions reached in its recent reports, the board might find it hard to justify participating formally in the programme.

The euro zone and the IMF have been at loggerheads over how to deal with Greece since the government of Alexis Tsipras, the prime minister, signed up for a third bail-out programme in August 2015. The IMF has held back from officially supporting the programme, arguing that a medium-term annual primary surplus target of 3.5% is unrealistic. The Fund argues that the government will have to undertake far more stringent austerity measures than are envisaged in the current bail-out programme to meet the primary surplus targets set by the euro zone. Assuming that the targets will not be achieved and sustained over the medium term, the IMF argues that substantive debt restructuring is necessary to make the debt sustainable. On occasion, and despite attempts to keep their differences private, disagreement has burst into the open. For the euro zone generally, and for Germany in particular, debt restructuring in the form of a write-down is a political no-no.

Populist pressures

Greece will need a new loan tranche in the third quarter, when it is due to make substantial debt payments. It needs to pay a little more than €6bn to private-sector and official creditors in July 2017. In the meantime, the country's lenders have no incentive to go easy on Greece, especially in the context of forthcoming elections in the Netherlands, France and Germany, where mainstream politicians and parties are under strong pressure from insurgent populist parties. It is likely that, in the cause of being seen to be tough on Greece, the country's creditors will insist that the government must implement all programme measures. Several euro zone parliaments, notably in Finland, Germany and the Netherlands, are obliged to vote on each loan disbursement to Greece; and the IMF's involvement in the programme has even become a legal requirement.

Meanwhile, in Greece, the second review is considerably behind schedule. The first review was finalised in October 2016, a year after the original deadline, and the second was slow to get under way. A deadline of January has already slipped to February and there is no end in sight. Only about a third of the targets have been fulfilled, according to the finance ministry, and another third are supposed to be completed in the coming weeks. The final third will be completed once an overall agreement has been reached.

Syriza dilemmas

The two sides have yet to agree on measures to meet the 2018 budget primary surplus target of 3.5% of GDP. The creditors say that measures worth €700m must be agreed; the government insists that labour market reforms and energy sector liberalisation will bring in €550m. The government continues to balk also at the creditors' insistence that budget primary surplus targets equivalent to 3.5% of GDP be maintained from 2018 onwards, indefinitely. It is also protesting about the IMF's insistence on the need for additional precautionary measures in case of a failure to meet fiscal targets.

However, despite all the noise about the primary surplus, labour reform is much more likely to prove a deal-breaker for Syriza Unifying Social Front (Syriza). Its complaints about a so-called automatic fiscal stabiliser mechanism could be a decoy intended to divert attention from the labour market reforms it is being asked to adopt. This may become a red line that some Syriza militants are not prepared to cross. There is much disquiet within the party at the measures the government is expected to implement. As Syriza's ratings plummet, some may begin to wonder whether the best course might be to try to save the party by bringing down the government on a point of principle.

We do not expect the second review to be finalised in February, ahead of elections in the Netherlands in March, and it may well drag on for months. Further delay and uncertainty about Greece's ability to meet its payments schedule in July will have a negative effect on the real economy and on the banking sector, which is already suffering a further haemorrhage of deposits in early 2017, despite the capital controls regime.

A decision by the IMF board not to participate formally in the bail-out programme will not necessarily lead to its cessation. Euro zone leaders have shown on many occasions a great facility for finding a way round apparently insoluble problems. However, such a decision would inevitably raise further doubts about the viability of the bail-out programme, which we have said from the start will prove almost impossible to implement and which is unlikely in any case to deliver growth. We are not inclined to change our forecast that Greece will leave the euro zone by the end of our 2017‑21 forecast period.